Just One Sector – Fuel Efficiency Pure Plays

John Petersen

In 1789 Benjamin Franklin wrote "in
this
world
nothing is certain but death and taxes." Today he
probably would have written "in this world nothing is certain but
death, taxes and rising oil prices." There's no escaping the misery,
but astute investors who take the time to understand the fundamental
trends can profit as the misery unfolds. For the short term, I'm
convinced the biggest opportunities will be in fuel
efficiency technologies for cars and light trucks.

After 20 years of complacent stagnation, the US started to get serious
about light-duty vehicle fuel efficiency in 2005 and has made solid
progress with improvements in the 14% to 18% range. The rate of change
will ramp rapidly over the next five years as aggressive new CAFE
standards that were adopted in April 2010 take effect. The following
graph provides an at a glance summary of new light-duty vehicle fuel
efficiency over the last 30 years and new fuel efficiency standards for
the next five years.

The usual
diversified group of first tier manufacturers of automobiles and
component systems will control two of the three technologies. Only one,
stop-start idle elimination, offers a pure-play
opportunity with a certain outcome.

Stop-start is the most sensible fuel efficiency technology you can
imagine – turn off the engine while the car is stopped in traffic.
While the
concept is simple, implementation is a beast because drivers
typically want their sound systems, climate control, lights and other
accessories
to keep working when the engine is off. Therefore, the key enabling
technology for start-stop systems is a better starter battery.

Traditionally, a battery had to start a car once during a normal trip.
With a stop-start system, however, the battery has to start the engine
an average of once per mile and carry critical accessory loads while
the engine is off. For a one-minute engine-off cycle, the accessories
will demand ten times as much energy as the starter. For a 15-mile
commute with one engine-off cycle per mile, the battery will have to
deliver 165
times
the
energy that it would in a car without stop-start. The
battery load is immense, but an optimized stop-start system can slash
fuel consumption in city driving by up to 15% and do it for an
incremental capital investment in the $400 to $800 range.

The normal flooded lead-acid batteries we've used for decades simply
can't stand up to the demands of stop-start systems. That reality has
forced automakers to rely on cut-out systems that disable the
stop-start function when the battery's state of charge falls below a
minimum level, and won't re-enable the stop-start function until the
battery recovers an acceptable state of charge. The result is
stop-start systems that don't function anywhere near peak efficiency.
To minimize problems, automakers are currently using dual battery
systems and upgrading to absorbed glass mat, or AGM, batteries.

In recognition of the shortcomings of flooded batteries, the leading
battery manufacturers are building new AGM battery production capacity
at a blistering pace. In 2007, Johnson Controls (JCI),
the world's
biggest battery manufacturer, had global production capacity for
400,000 AGM batteries per year. Their announced expansion projects will
boost that capacity to 11.2 million AGM batteries per year by 2014 and
further expansions in the US are being discussed. Exide Technologies
(XIDE)
is also on an expansion spree that will boost its AGM battery
capacity from 500,000 units in 2009 to 3.5 million units in 2013. On a
worldwide basis, Lux Research forecasts that AGM battery demand will
soar by 800% over the next five years, from three million units in 2010
to 27 million units in 2015. As they substitute higher margin AGM
batteries for lower margin flooded batteries, the revenues and margins
of leading battery manufacturers including JCI, Exide and to a lesser
extent Enersys (ENS)
will soar. Their stock prices will follow suit.

While AGM batteries are currently the best available technology for
stop-start systems, they are far from ideal because their ability to
recover an optimal state of charge deteriorates rapidly as the battery
ages. Using simulation protocols from BMW and Ford, researchers have
learned that the time required for an AGM battery to recover from an
engine-off event increases from 50 to 60 seconds with a new battery to
4 or 5 minutes with a battery that's been in service for six months.
The bottom line is automakers need a better solution than AGM
batteries. Until a better solution comes along, however, the AGM
battery will reign supreme as the battery of choice for the stop-start
market.

The two principal contenders for "better solution" honors are:

A multi-component system from Continental AG and Maxwell
Technologies (MXWL)
that combines an AGM battery, a
small
supercapacitor
module and associated control electronics in a
system that eliminates the voltage drops and black screens that
commonly occur when the
starter engages at the end of an engine-off cycle; and

The third generation lead-carbon battery from Axion Power
International (AXPW.OB)
that replaces the lead-based negative electrode
in a conventional AGM battery with a carbon electrode assembly that
boosts cycle life by 400% and provides consistent charge recovery times
of about 35 seconds through four years of simulated use.

The Maxwell - Continental system is available now and was recently
selected by
PSA Peugeot Citroën for use in Citroën C4 and C5 diesels
featuring
PSA's e-HDi second generation micro hybrid system. With an estimated
three-year value in the $50 million range, this design win should
provide a significant boost for Maxwell's top-line revenue. Despite its
advantages, however, the Maxwell - Continental system is not an ideal
solution because the supercapacitor can slow but it can't stop the
deterioration of the AGM battery it's paired with. So over time,
vehicles equipped with the Maxwell-Continental system will suffer the
same kind of performance degradation that all other stop-start systems
exhibit.

The most promising solution to the challenges of stop-start, the
PbC® battery from Axion, is in the final development stages and
won't be ready for a large-scale commercial rollout until 2012. Axion is currently
installing a second-generation fabrication line for their serially
patented carbon electrode assemblies and potential customers should
begin validation testing on the new fabrication processes and equipment
soon. Once its potential customers validate the fabrication process,
the last major step will be to build additional electrode fabrication
capacity so that Axion can manufacture PbC batteries on its own AGM
battery line and sell electrode assemblies to other AGM manufacturers.
Since the PbC electrodes are designed to work as plug-and-play
replacements for traditional lead-based electrodes, Axion should be
uniquely positioned to leverage existing AGM battery manufacturing
capacity while giving other battery manufacturers the opportunity to
sell a premium product to their existing customers.

While the PbC battery is still a development stage technology and Axion
is just barely out of the nano-cap range with a $60 million market
capitalization, its roster of disclosed industry relationships is
extraordinary. Axion has longstanding relationships with both East Penn
Manufacturing and Exide, the second and third largest AGM battery
manufacturers in North America; it has a service contract to develop a
battery management system for Norfolk Southern (NS) which wants to
retrofit a portion of its 3,500 unit locomotive fleet with hybrid
drive; and the PbC battery has demonstrated
exceptional performance
during 18 months of testing by
BMW, the industry leader in stop-start with over a million EfficientDynamics vehicles on
the road today. In over 30 years as a small company securities lawyer,
I've never seen another company that was able to generate a
comparable level of interest and involvement from the giants in its
industry.

The energy storage sector offers a wide range of fuel efficiency pure
plays. The following table provides summary
data on key financial (in millions) and market metrics that I consider
important. While JCI is not technically an energy storage pure play
because of its
diversified
operations in auto parts and building efficiency, I've included it in
this list because 14.6% of its revenues and 52.5% its earnings are
derived from battery manufacturing operations.

While I closely follow the energy storage and vehicle electrification
sectors and am convinced that every manufacturer who can bring a
cost-effective product to market will have more demand than it can
handle, these five companies have the clearest paths to market beating
growth over the next five years and are my favorites for that reason.
JCI, Enersys, Exide and Maxwell have been stellar performers since
December 31, 2008 with market crushing gains of 126% to 264%. Axion has
been the laggard of the group, losing 39% of its market value it raised
new capital in a brutal market and worked to complete the development
of its promising PbC technology and start climbing out of the valley of
death. For the next few years, I expect the entire group to outperform
the market by a wide margin because the die is already cast.

Fuel efficiency has been a hot topic in the automotive world for the
last five years and new regulations in the US and EU will provide a
massive impetus for immediate change. Increasing political turmoil in
oil producing regions can only add to the sense of urgency. There is a
wide variety of potential long-term solutions, but short-term solutions
to immediate problems are very limited. For the next five years,
stop-start will be at or near the top of the list.

Disclosure: Author is a former
director of Axion Power International (AXPW.OB)
and holds a substantial long position in its common stock.

Comments

One thing that you overlook in this article is that gasoline direct injection with peizo-electric injectors (which is what looks most promising) allows for elimination of the start motor on vehicles. The way this works is that the engine stops with pressure in a cylinder just past top dead center. When it is time to start, the system injects fuel, ignites the spark, and the engine starts up again.

There is still the accessory loading, but at least the starter motor loading is minimal.

Gasoline direct injection reduces starter load but does not eliminate the need for a starter. You still need a starter but it doesn't have to work very hard. Even if you zero out the starter load, however, the accessory load is over 90% of the problem, which means GDI won't contribute much to the mix.